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U.S. Rate Hikes Hit Rest of World Just as Hard, Fed Paper Says

(Bloomberg) -- Federal Reserve officials often like to say their mandate is to conduct monetary policy for the U.S. first and foremost. Amid a sell-off in emerging markets, a new study conducted by researchers at the central bank suggests higher interest rates at home have as big an effect abroad as they do here.

“The foreign spillovers of higher U.S. interest rates are large, and on average nearly as large as the U.S. effects," Fed economists Matteo Iacoviello and Gaston Navarro wrote in a paper published Monday on the central bank’s website.

“A monetary policy-induced rise in U.S. rates of 100 basis points reduces GDP in advanced economies and in emerging economies by 0.5 and 0.8 percent, respectively, after three years,” they wrote. “These magnitudes are in the same ballpark as the domestic effects of a U.S. monetary shock, which reduce U.S. GDP by about 0.7 percent after two years.”

The pair found that higher U.S. rates slow other advanced economies primarily through their effects on exchange rates and trade. Emerging economies, on the other hand, were more affected via so-called financial fragility channels -- a concept that encompasses things like current account balances, foreign reserves, inflation and external debt.

MSCI’s index of shares of companies based in emerging markets fell Monday to the lowest level since December as the U.S. dollar extended nearly a month of gains.

“Our findings also highlight both the bright and the dark side of foreign responses to U.S. interest rate increases,” Iacoviello and Navarro wrote.

“On the dark side, these responses seem to be large, to the point that they suggest that foreign economies -- especially vulnerable, emerging economies -- may react to U.S. monetary shocks more so than the U.S. economy itself,” they wrote. “On the bright side, they illustrate how countries that succeed in keeping their financial house in order can weather foreign shocks relatively better than their vulnerable counterparts.”